Part I: Theoretical Background
capital, there is no motivation in terms of compensation for investors
to correctly state the value or for customs authorities to monitor the
declared value. A further problem may be encountered when foreign
investment agencies have an incentive to boost their investment figures,
resulting in a common interest between the agency and the investor to
inflate the amount of the investment. It is thus important for the tax
administration to be involved in the valuation process.
Abuse of duty-free privileges A common investment incentive is an exemption from customs duty
on imported equipment. Once imported, however, items may be
resold on the domestic market. A partial solution is to restrict the
exemption to those assets that are contributed to the charter capital
of the enterprise, but it still may be necessary to verify periodically
that the assets remain in the enterprise. Another approach is to restrict
the exemption to assets such as machinery, which are less likely to be
resold, and to exclude items such as passenger vehicles and computer
equipment.
Asset stripping and “fly-by-night” operations Many countries have experienced problems with “fly-by-night”
operators that take advantage of tax incentives to make a quick,
tax-free profit and then leave to begin operations in another country
that offers tax privileges. This problem most often arises with the use
of tax holidays and export processing zones. Another problem occurs
when a foreign investor acquires control of an existing local enterprise
and, instead of contributing new capital to modernize the enterprise,
strips it of its useful assets and leaves the country. The latter problem
is not necessarily linked to the availability of tax incentives, although
the ability to make a tax-free capital gain is an added attraction to the
investor stripping the assets.
Some countries have attempted to counter the fly-by-night
operator problem by introducing “clawback” provisions. For exam-
ple, a country can grant a tax holiday for a 5-year period only if the
venture continues for a period of 10 years. If the venture is termi-
nated before the end of the 10-year period, any tax that was fore-
gone must be repaid. The difficulty with such a provision is that the
32
Design and Assessment of Tax Incentives
investor may have left the country before it is possible to claw back
any of the forgiven tax liability.